China Dairy Market Development Strategy Outlined During D20

Overview

On Nov. 27, 2019, China D20 Summit Meeting was held in Shanghai ^[1], the meeting mainly focused on the development of China's dairy industry in recent years. The Ministry of Agriculture and Rural Affairs (MoA) issued the 2019 China Dairy Quality Report. Besides, relevant industry authorities made plans and forecasts for the future development of the dairy market.

Remark: "D20" refers to the top 20 Chinese dairy companies. The latest D20 enterprises alliance (as shown below) organized in the year 2018, which replaced the first list released in 2015.
Overall, China's major dairy companies maintained good growth, mainly attributable to two factors. The first contributing factor was consolidation in the market. In 2018 there were 587 domestic dairy processing enterprises above a designated scale, which was 71 less than the number in 2013. Price is another influential factor. In 2018, the average retail price of milk in China was 11.6 yuan/kg, up 19.6% in five years. For products like yoghurt and milk powder, retail prices rose an average of 13.4% and 15%, respectively, compared to 2013.

However, according to the 2019 China Dairy Quality Report, China's dairy output in 2018 was 26.87million tons, down 0.4% from 2013. Moreover, the growth rate of dairy consumption in China is slowing down. In the past decade, the average annual growth of dairy consumption is only 0.8kg, which is much lower than the 2kg seen in the previous decade.

Although dairy companies still enjoy high profits and steady market growth, the overall slowdown in dairy consumption is worrying. The existing problems can be summarized as follows:

Chinese Milk Lacks (奶剩): Supply and demand have become decoupled of late. Drinking liquid milk is by far the most popular method of dairy consumption in China. In the early part of the decade, demand for liquid milk was trending upwards, and forecasts were optimistic. Anticipating continued demand, most companies significantly scaled up their liquid milk production capacities. However, the expected growth in demand never materialized, and instead, there was a palpable contraction in consumption, which lead to overproduction.

Failure to address evolving consumer preference (奶荒): China currently does not produce enough cheese, butter, and other niche value-added dairy products and ingredients to meet demand. For example, Chinese buyers and consumers are now more eager to get high-quality raw materials like creamers for teas and coffees, but the current market lacks high-grade products to meet this demand.
So, where are the next opportunities in the dairy market? Competition is fierce, and the market is saturated. Companies must offer more value to entice consumers, and across the board, we see a shift towards higher quality products. A2 milk, goat's milk, lactose-free, vitamin-fortified, or other innovative offerings are crucial to differentiate a product. Targeting emerging segments is another high-yield strategy, and companies can also consider meeting unmet demand in the value-added dairy segments.

Product Upgrade: Transitioning from "Quantity" to "Quality"

1. The Quality of Cows

At present, 90% of China's breeding bulls are imported from abroad ^[2]. The annual milk yield of Chinese cows is 7.4 tons of milk per cow, compared with 10.3 tons in the United States.

Deng Xingzhao, director of the dairy department of the MoA, outlined vital tasks to improve the situation. The main checkpoints of China's next phase of dairy sector reforms are to develop a large group of high-yielding dairy cows, all with an annual yield of more than 10 tons. Deng Xingzhao also pledged that the government would support the construction of 1 million mu (approx. 164k acre) of high-quality alfalfa base every year and encourage 1,500 small and medium family farms to improve their technical capacities.

2. Hygiene Index

In 2018, the qualification rate of fresh milk products inspected by authorities reached 99.9% ^[3]. Dairy products and infant formula milk powder reached more than 99.5%. Nutritional indicators, such as milk protein, milk fat, and safety indicators, such as the total number of bacterial colonies, reached the level of developed countries. The publication of the data also boosted consumer confidence in domestic dairy products.

3. Regulatory Compliance

Early on Feb. 20, 2018^[4], related organizations subordinated to MoA released the first discussions on proposed revisions to the national food safety standard for raw milk, pasteurized milk, sterilized milk, and identification of reconstituted milk. Apart from the adjustments of some physicochemical indexes, the discussion drafts proposed to grade raw milk and standardize the use of reconstituted milk. Corresponding physicochemical indexes are designed to classify raw milk into "premium," "good," and "qualified" levels. For example, the protein contents for raw milk of those three levels are 3.2 g/100g (premium), 3.0 g/100g (good), and 2.8 g/100g (qualified), respectively.

4. The Category of Liquid Milk

Liquid milk is the most essential product in China's dairy industry. In the short term, liquid milk is unlikely to be replaced by other kinds of dairy products. However, due to market saturation, it is now necessary to develop better liquid milk.

Pasteurized fresh milk had a market share of about 15.2% in 2017, and even in 2018, this figure didn't surpass 20%, UHT milk (ultra-high temperature processing milk) accounted for 84.8% of the market in 2017.

Pasteurized milk retains more nutrients than UHT milk and is perceived as healthier than UHT by Chinese consumers. Pasteurized milk also offers a better profit margin for dairy enterprises. In China, the gross margin of low-temperature processed liquid milk is 42.87%, far higher than the 24.67% of UHT milk.

During D20, China's top dairy manufacturers like Bright dairy, Sanyuan, Weigang, etc. jointly published a new group standard of pasteurized milk. Furthermore, to help distinguish UHT milk from pasteurized milk, these enterprises have called for the development of a national standard to define and regulate the active substances index.

China Expecting a Spike in Sales of Solid Dairy

According to the 2019 China Dairy Quality Report, China produced 25.06 million tons of liquid milk in 2018. Despite a 7.3% increase over 2013, liquid milk production growth has been trending downwards since 2017 ^[5].

Slowing domestic dairy consumption is primarily associated with the limitation inherent in China's dairy industry structure. Consumers have traditionally preferred to get their dairy by drinking milk. However, growth in this area has already plateaued. By contrast, in Europe, the US and other countries, cheese, butter, and other solid dairy products play important roles and hold a far more significant share of the dairy market. In 2018, the per capita consumption of cheese in China was just 0.1 kg, which is minuscule when compared with this figure in the US (17.2 kg) and that in the European Union (18.3 kg).

Remark: 1kg of cheese is equivalent to 10kg of fresh milk. To learn more about China's cheese market, please click here.

Lu Minfang, CEO of Mengniu, said that because of the "westernization" of domestic catering, that "invisible consumption" of dairy products is growing. That is, demand for cheese and butter is increasing, and trending dairy products are continually emerging and driving demand, such as milk teas and coffee. It is worth mentioning that the leading Chinese dairy enterprises, including Yili, Mengniu, Bright Dairy, etc. have all invested heavily in cheese and raw materials business development.